This Weekend in Barron's: Sector PE Ratios, Foreign Markets

by: Roger Nusbaum

Barron's had a couple of interesting nuggets this weekend. First was an article commemorating, in a manner of speaking, the one year anniversary of what appears to be the low. The article went on to make a bullish case for domestic and foreign equities. I would not say the article pounded the table with bullishness but there were a couple of items worth commenting on.

There was a bit on the US market broken down to the sector level (well, eight of the ten sectors), showing current PE ratios versus historical PE ratios to make the argument that they are cheap. If you do a little research, you will see that PEs can stay low or high for quite a while without much in the way of predicative value.

The article then went on to make the case for some foreign markets. Unfortunately the focus was limited to the big three in Europe (UK, France and Germany), Japan and Hong Kong. Maybe 'unfortunately' is the wrong word. It would be unfortunate for people who have not done much with foreign investing and do not realize that Europe could be worse off fundamentally than the US. It would be difficult to not realize what a basket case Japan is and that the Hang Seng is very heavy in real estate, which could be problematic for people picking Hong Kong through the iShares Hong Kong Fund (NYSEARCA:EWH).

It is not unfortunate for people willing to some homework and seek out countries with much firmer fundamentals. Unfairly or not, the Barron's article could be viewed as proxy for what most people think of when they set out to invest in foreign stocks. 2009 shows us that countries with poor fundamentals can go up a lot, but countries with solid fundamentals went up a lot, too. It should be obvious that you have more margin for error favoring solid fundamentals over lousy fundamentals. Some countries I favor are Norway, Israel, Canada, Brazil, Australia, Chile and China.

The other item from Barron's was the interview with the two managers of the RS Global Natural Resources Fund (RSNRX). What was peculiar was that there were at least three different pokes at related ETFs. I found it odd, in a way, that the managers of this active fund would tell you why ETFs are inferior. In the lead in to the interview, Barron's noted that their fund had outperformed the S&P North American Natural Resources Sector Index, which is nice but the fund is a global fund, not a North America one.

In comparing RSNRX to the iShares Global Materials ETF (NYSEARCA:MXI), which I own for some clients, you see that the ETF outperformed for the trailing 12 months by almost 20%, for calendar year 2009 by about 5%; in calendar year 2008, the ETF lagged by 2-3%, and in calendar year 2007, the ETF outperformed by 10%. The ETF debuted in late 2006, so that is about as far back as we can go.

It would not have occurred to me to even look had they not jabbed at ETFs the way that they did. Actively managed mutual funds are collectively in a tough spot. The managed funds are much more expensive and the track record for outperfomance is spotty at best. Plenty of funds end up adding value but there is no way to know whether a fund that has previously added value will do so again. How many times have you heard someone from Morningstar give an opinion on CNBC as to why they think some manager will have a good year? How is that anything but a guess?

For all I know RSNRX might go on a great run and crush MXI, but it was a strange justification after having lagged so consistently of late.